10-Q

FORM 10-Q

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

(Mark One)
[ x ]	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended December 31, 2002.
	OR
[   ]	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ____________________ to ____________________
Commission file number 000-23084.

Integrated Silicon Solution, Inc.

Delaware	77-0199971
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)
2231 Lawson Lane, Santa Clara, California	95054
(Address of principal executive offices)	zip code

Registrant’s telephone number, including area code (408) 588-0800.

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

     Yes [x] No [   ]

     Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

     Yes [   ] No [x]

     The number of outstanding shares of the registrant’s Common Stock as of February 6, 2003 was 27,769,397

TABLE OF CONTENTS

Condensed Consolidated Statements of Operations
Condensed Consolidated Statements of Comprehensive Loss
Condensed Consolidated Balance Sheets
Condensed Consolidated Statements of Cash Flows
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
	Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations
	Item 3.   Financial Market Risk
	Item 4.   Controls and Procedures
Part II. OTHER INFORMATION
	Item 6.   Exhibits and Reports on Form 8-K
SIGNATURES
EXHIBIT 99.1

Integrated Silicon Solution, Inc.
Condensed Consolidated Statements of Operations
(Unaudited)
(In thousands, except per share data)

			Three Months Ended
			December 31,
			2002			2001
Net sales (See Note 13)			$	21,038		$	15,091
Cost of sales				22,260			12,400
Gross profit (loss)				(1,222	)		2,691
Operating Expenses:
	Research and development			6,805			6,638
	Selling, general and administrative			3,658			3,665
		Total operating expenses		10,463			10,303
Operating loss				(11,685	)		(7,612	)
Gain on sale of investments				—			35
Other income (expense), net				18			536
Loss before minority interest and equity in net loss of affiliated companies				(11,667	)		(7,041	)
Minority interest in net loss of consolidated subsidiary				17			9
Equity in net loss of affiliated companies				(1,039	)		(2,906	)
Net loss			$	(12,689	)	$	(9,938	)
Basic and diluted net loss per share			$	(0.46	)	$	(0.37	)
Shares used in basic and diluted per share calculation				27,565			26,598

See accompanying notes to condensed consolidated financial statements.

Integrated Silicon Solution, Inc.
Condensed Consolidated Statements of Comprehensive Loss
(Unaudited)
(In thousands)

		Three Months Ended
		December 31,
		2002			2001
Net loss		$	(12,689	)	$	(9,938	)
Other comprehensive income (loss), net of tax:
	Change in cumulative translation adjustment		139			(296	)
	Change in unrealized loss on investments		(248	)		—
Comprehensive loss		$	(12,798	)	$	(10,234	)

See accompanying notes to condensed consolidated financial statements.

Integrated Silicon Solution, Inc.
Condensed Consolidated Balance Sheets
(In thousands)

		December 31,			September 30,
		2002			2002
		(unaudited)			(1)
ASSETS
Current assets:
	Cash and cash equivalents	$	17,484		$	11,622
	Short-term investments		57,500			67,200
	Accounts receivable		8,636			7,445
	Accounts receivable from related parties (See Note 13)		699			946
	Inventories		12,437			17,665
	Other current assets		2,950			3,448
Total current assets			99,706			108,326
Property, equipment, and leasehold improvements, net			10,010			10,673
Other assets			64,260			65,677
Total assets		$	173,976		$	184,676
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
	Accounts payable	$	15,892		$	17,871
	Accounts payable to related parties (See Note 13)		7,269			3,905
	Accrued compensation and benefits		3,368			3,394
	Accrued expenses		4,437			3,830
	Current portion of long-term obligations		116			158
Total current liabilities			31,082			29,158
Minority interest			78			95
Stockholders’ equity:
	Common stock		3			3
	Additional paid-in capital		231,178			231,032
	Accumulated deficit		(81,940	)		(69,251	)
	Unearned compensation		(733	)		(778	)
	Accumulated comprehensive loss		(5,692	)		(5,583	)
Total stockholders’ equity			142,816			155,423
Total liabilities and stockholders’ equity		$	173,976		$	184,676

(1) Derived from audited financial statements.
See accompanying notes to condensed consolidated financial statements.

Integrated Silicon Solution, Inc.
Condensed Consolidated Statements of Cash Flows
(Unaudited)
(In thousands)

			Three Months Ended
			December 31,
			2002			2001
Cash flows from operating activities
	Net loss		$	(12,689	)	$	(9,938	)
	Depreciation and amortization			1,246			871
	Amortization of intangibles and unearned compensation			66			—
	Gain on sale of investments			—			(35	)
	Loss on imbedded derivative			277			—
	Loss on impairment of investment			—			150
	Net foreign currency transaction losses			17			—
	Equity in net loss of affiliated companies			1,039			2,906
	Minority interest in net loss of consolidated subsidiary			(17	)		(9	)
	Net effect of changes in current and other assets and current liabilities			6,681			5,023
		Cash used in operating activities		(3,380	)		(1,032	)
Cash flows from investing activities
	Capital expenditures			(583	)		(857	)
	Purchases of available-for-sale securities			(11,150	)		(6,600	)
	Sales of available-for-sale securities			20,850			18,400
	Proceeds from sale of Integrated Circuit Solution, Inc. (“ICSI”) equity securities			—			64
	Proceeds from minority shareholders of D2Code			—			145
	Investment in Semiconductor Manufacturing International Corp. (“SMIC”)			—			(3,750	)
	Other investments			—			(16	)
		Cash provided by investing activities		9,117			7,386
Cash flows from financing activities
	Proceeds from issuance of common stock			146			400
	Principal payments on notes payable and long-term obligations			(42	)		(38	)
		Cash provided by financing activities		104			362
Effect of exchange rate changes on cash and cash equivalents				21			(65	)
Net increase in cash and cash equivalents				5,862			6,651
Cash and cash equivalents at beginning of period				11,622			19,309
Cash and cash equivalents at end of period			$	17,484		$	25,960

See accompanying notes to condensed consolidated financial statements.

INTEGRATED SILICON SOLUTION, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

1.   Basis of Presentation

     The accompanying condensed financial statements include the accounts of Integrated Silicon Solution, Inc. (the “Company”) and its consolidated majority owned subsidiaries, after elimination of all significant intercompany accounts and transactions and have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments considered necessary for fair presentation have been included.

     Operating results for the three months ended December 31, 2002 are not necessarily indicative of the results that may be expected for the year ending September 30, 2003 or for any other period. The financial statements included herein should be read in conjunction with the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2002.

2.   Concentrations

     In the three months ended December 31, 2002 and December 31, 2001, no single customer accounted for over 10% of net sales. However, in the three months ended December 31, 2001, shipments for Cisco Systems Inc. (“Cisco”) directly, or indirectly through subcontractors, accounted for approximately 14% of net revenue.

3.   Cash, Cash Equivalents and Short-term Investments

     Cash, cash equivalents and short-term investments consisted of the following:

	(In thousands)
	December 31		September 30
	2002		2002
Cash	$	12,435	$	6,327
Money market instruments		5,049		5,295
Municipal bonds due in more than 3 years		57,500		67,200
	$	74,984	$	78,822

5

INTEGRATED SILICON SOLUTION, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

4.   Inventories

     The following is a summary of inventories by major category: (In thousands)

	December 31		September 30
	2002		2002
Purchased components	$	4,163	$	4,436
Work-in-process		467		724
Finished goods		7,807		12,505
	$	12,437	$	17,665

     In the three months ended December 31, 2002 and in fiscal 2002, the Company recorded inventory write-downs of $4.1 million and $28.6 million, respectively. The inventory write-downs were predominately for lower of cost or market and excess and obsolescence issues on certain of its products.

5.   Other Assets

     Other assets consisted of the following:

	(In thousands)
	December 31		September 30
	2002		2002
Investment in ICSI common stock	$	14,694	$	15,690
Investment in ICSI convertible debenture		2,494		2,943
Investment in SMIC		40,000		40,000
Other		7,072		7,044
	$	64,260	$	65,677

     The market value of the Company’s investment in the common stock and convertible debentures of ICSI at December 31, 2002 was approximately $26,970,000 and $2,494,000, respectively, based on quoted market prices.

6.   Accumulated Comprehensive Loss

     The accumulated comprehensive loss component within the stockholders’ equity section of the Balance Sheet is comprised of foreign currency translation adjustments and the unrealized loss on an investment.

     The components of accumulated other comprehensive loss, net of tax, were as follows:

	December 31			September 30
	2002			2002
	(In thousands)
Accumulated foreign currency translation adjustments	$	(5,206	)	$	(5,345	)
Accumulated net unrealized loss on available-for-sale investments		(486	)		(238	)
Total accumulated other comprehensive loss	$	(5,692	)	$	(5,583	)

6

INTEGRATED SILICON SOLUTION, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

7.   Income Taxes

     The Company recorded no provision for income taxes for the three month periods ended December 31, 2002 and December 31, 2001 due to its net operating loss position.

8.   Net Loss Per Share

     The following table sets forth the computation of basic and diluted net loss per share (in thousands, except per share amounts):

	Three Months Ended
	December 31,
	2002			2001
Numerator for basic and diluted net loss per share:
Net loss	$	(12,689	)	$	(9,938	)
Denominator for basic and diluted net loss per share:
Weighted average common shares outstanding		27,565			26,598
Basic and diluted net loss per share	$	(0.46	)	$	(0.37	)

     The above diluted calculation does not include approximately 6,188,000 and 4,730,000 shares attributable to options as of December 31, 2002 and 2001, respectively, as their impact would be anti-dilutive.

9.   Use of Estimates

     The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates, and such difference, may be material to the financial statements.

10.   Impact of Recently Issued Accounting Standards

     In October 2001, the Financial Accounting Standards Board issued SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” which addresses financial accounting and reporting for the impairment or disposal of long-lived assets. While SFAS No. 144 supersedes FASB Statement No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,” it retains many of the fundamental provisions of that Statement. SFAS No. 144 also supersedes the accounting and reporting provisions of APB Opinion No. 30, “Reporting the Results of Operations-Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions,” for the disposal of a segment of a business. However, it retains the requirement in Opinion No. 30 to report separately discontinued operations and extends that reporting to a component of an entity that either has been disposed of (by sale, abandonment, or in a distribution to owners) or is classified as held for sale. The Company adopted these standards as of October 1, 2002. The adoption of SFAS No. 144 did not have a material effect on the Company’s financial position and results of operations.

7

INTEGRATED SILICON SOLUTION, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

     In July 2002, the Financial Accounting Standards Board issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities”. SFAS No. 146 addresses the financial accounting and reporting for obligations associated with an exit activity, including restructuring, or with a disposal of long-lived assets. Exit activities include, but are not limited to, eliminating or reducing product lines, terminating employees and contracts and relocating plant facilities or personnel. SFAS No. 146 specifies that a company will record a liability for a cost associated with an exit or disposal activity only when that liability is incurred and can be measured at fair value. Therefore, commitment to an exit plan or a plan of disposal expresses only management’s intended future actions and, therefore, does not meet the requirement for recognizing a liability and the related expense. SFAS No. 146 is effective prospectively for exit or disposal activities initiated after December 31, 2002, with earlier adoption encouraged. The adoption of SFAS No. 146 will not have a material effect on the Company’s financial position or results of operations.

     In November 2002, the Financial Accounting Standards Board issued FASB Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others,” (FIN 45). FIN 45 requires that upon issuance of a guarantee, a guarantor must recognize a liability for the fair value of an obligation assumed under a guarantee. FIN 45 also requires additional disclosures by a guarantor in its interim and annual financial statements about the obligations associated with guarantees issued. The recognition provisions of FIN 45 are effective for any guarantees issued or modified after December 31, 2002. The disclosure requirements are effective for financial statements of interim or annual periods ending after December 15, 2002. The Company has adopted the disclosure requirements for the financial statements included in this Form 10-Q. The adoption of FIN 45 did not have a material effect on the Company’s financial position, results of operations, or cash flows.

     In December 2002, the Financial Accounting Standards Board issued SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure”. SFAS No. 148 amends SFAS No. 123 to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The transition guidance and annual disclosure requirements are effective for interim and annual periods beginning after December 15, 2002. The Company will adopt the disclosure requirements for the quarter ended March 31, 2003. The Company will continue to account for stock-based compensation under the provisions of APB Opinion No. 25 using the “intrinsic value” method. Accordingly, the adoption of SFAS No. 148 is not anticipated to have a material effect on the Company’s financial position, results of operations, or cash flows.

11.   Commitments and Contingencies

        Commitments to Wafer Fabrication Facilities

     At December 31, 2002, the Company had a remaining non-cancelable purchase commitment to a wafer foundry for approximately $609,000 by June 30, 2003. The Company purchased approximately $603,000 under this commitment in the three months ended December 31, 2002.

8

INTEGRATED SILICON SOLUTION, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

12.   Geographic and Segment Information

     The Company has one operating segment, which is to design, develop, and market high-performance SRAM, DRAM, and other memory products. The following table summarizes the Company’s operations in different geographic areas:

		Three Months Ended
		December 31,
		2002		2001
		(In thousands)
Net Sales
	United States	$	4,113	$	6,928
	China		3,302		1,774
	Hong Kong		3,319		1,249
	Taiwan		3,657		1,652
	Korea		1,928		214
	Asia / Pacific other		2,020		1,161
	Europe		2,683		2,113
	Canada		16		—
	Total net sales	$	21,038	$	15,091

		December 31,		September 30,
		2002		2002
		(In thousands)
Long-lived assets
	United States	$	7,059	$	7,942
	Hong Kong		667		691
	China		2,044		1,771
	Other foreign locations		240		269
		$	10,010	$	10,673

13.   Related Party Transactions

     For the three months ended December 31, 2002 and December 31, 2001, the Company sold approximately $118,000 and $515,000, respectively, of memory products to ICSI. The Company currently has approximately a 29% ownership interest in ICSI. The Company’s Chairman and Chief Executive Officer (“CEO”), Jimmy S.M. Lee, is a director of ICSI. The Company also provides services and licenses certain products to ICSI. At December 31, 2002 and September 30, 2002, the Company had an accounts receivable balance from ICSI of approximately $503,000 and $560,000, respectively.

     The Company purchases goods and contract manufacturing services from ICSI. For the three months ended December 31, 2002 and December 31, 2001, purchases of goods and services were approximately $15,000 and $259,000, respectively. The Company also pays ICSI for certain product development costs, license fees and royalties. For the three months ended December 31, 2002 and December 31, 2001, these charges totaled approximately $46,000 and $783,000, respectively. At December 31, 2002 and September 30, 2002, the Company had an accounts payable balance to ICSI of approximately $174,000 and $777,000, respectively.

9

INTEGRATED SILICON SOLUTION, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

     The Company purchases services from NexFlash. The Company currently has approximately a 14% ownership interest in NexFlash. The Company’s Chairman and CEO, Jimmy S.M. Lee, is a director of NexFlash. For the three months ended December 31, 2002, purchases of services were approximately $11,000. At December 31, 2002 and September 30, 2002, the Company had an accounts payable balance to NexFlash of approximately $15,000 and $4,000, respectively.

     The Company provides goods and services to GetSilicon in which the Company currently has approximately a 17% ownership interest. The Company’s Chairman and CEO, Jimmy S.M. Lee, was the Chairman of GetSilicon until May 14, 2002 and continues to serve as a director. For the three months ended December 31, 2002 and December 31, 2001, the Company provided goods and services of approximately $19,000 and $44,000, respectively, to GetSilicon. At December 31, 2002 and September 30, 2002, the Company had an accounts receivable balance from GetSilicon of approximately $91,000 and $73,000, respectively.

     The Company engages GetSilicon for business-to-business data exchange and professional services. For the three months ended December 31, 2002 and December 31, 2001, the purchase of services was approximately $0 and $170,000, respectively. At December 31, 2002 and September 30, 2002, the Company had an accounts payable balance to GetSilicon of approximately $181,000 and $317,000, respectively.

     For the three months ended December 31, 2002 and December 31, 2001, the Company sold approximately $11,000 and $96,000, respectively, of memory products to E-CMOS in which the Company currently has approximately a 26% ownership interest. The Company’s Chairman and CEO, Jimmy S.M. Lee, is the Chairman of E-CMOS. At December 31, 2002 and September 30, 2002, the Company had an accounts receivable balance from E-CMOS of approximately $5,000 and $12,000, respectively.

     The Company receives administrative support services and reimburses E-CMOS for expenses incurred on its behalf. At December 31, 2002 and September 30, 2002, the Company had an accounts payable balance to E-CMOS of approximately $69,000 and $434,000, respectively.

     For the three months ended December 31, 2002 and December 31, 2001, the Company sold approximately $145,000 and $45,000, respectively, of memory products to Marubun USA Corporation (“Marubun”). Hide L. Tanigami, a director of the Company, is the president and chief executive officer of Marubun. At December 31, 2002 and September 30, 2002, the Company had an accounts receivable balance from Marubun of approximately $100,000 and $301,000, respectively.

     The Company purchases goods from SMIC in which the Company has less than a 4% ownership interest. The Company’s Chairman and CEO, Jimmy S.M. Lee, is a director of SMIC. For the three months ended December 31, 2002, purchases of goods from SMIC were approximately $7,502,000. At December 31, 2002 and September 30, 2002, the Company had an accounts payable balance to SMIC of approximately $6,830,000 and $2,373,000, respectively.

10

INTEGRATED SILICON SOLUTION, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

14.   Investment in Integrated Circuit Solution Inc. (“ICSI”)

     The following summarizes financial information for ICSI, an equity investee. (In thousands)

	December 31,		September 30,
	2002		2002
Current assets	$	70,150	$	77,026
Property, plant, and equipment and other assets		44,373		45,810
Current liabilities		34,429		39,516
Long-term debt		18,710		18,664

	Three Months Ended
	December 31,
	2002			2001
Net sales	$	19,634		$	14,625
Gross profit (loss)		439			(5,511	)
Net loss		(3,771	)		(9,984	)

     In the June 2002 quarter, the Company invested approximately $3.2 million in convertible debentures issued by ICSI. The Company classifies this investment as available-for-sale. ICSI raised approximately $17 million with the proceeds to be used for general working capital purposes. Key terms of the issuance included: 5 year term, 0% coupon rate, convertible into ICSI common stock after 90 days, four specified conversion dates per year, conversion price at 101% over a calculated average closing price, an anti-dilution clause, a put option at 4% interest after 3 years and 4.5% after 4 years, and callable after 2 years if the market price of ICSI common stock meets certain conditions.

     As a result of a decline in ICSI’s convertible bond price, the Company recorded an unrealized loss of approximately $248,000 related to the ICSI convertible debentures in the December 2002 quarter. The unrealized loss is included in accumulated other comprehensive loss. In addition, in the December 2002 quarter, the Company recorded a charge of approximately $277,000 related to the decline in the fair value of an embedded derivative associated with the ICSI convertible debenture. The charge associated with the embedded derivative is included in other income (expense). The market value of the Company’s convertible debentures at December 31, 2002 was approximately $2.5 million.

     The Company accounts for investments in 50 percent or less owned companies over which it has the ability to exercise significant influence using the equity method of accounting. At December 31, 2002 and September 30, 2002, approximately, $3.6 million and $4.6 million, respectively, of undistributed earnings of 50% or less owned companies accounted for using the equity method are included in consolidated retained earnings. The Company periodically reviews these investments for other-than-temporary declines in market value and writes these investments to their fair value when an other-than-temporary decline has occurred.

11

INTEGRATED SILICON SOLUTION, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Note 15.   Acquisition of Purple Ray

     On February 13, 2002, the Company acquired all of the outstanding shares of Purple Ray, Inc. (“Purple Ray”) through a merger of Purple Ray with and into ISSI pursuant to the terms of an Agreement and Plan of Reorganization dated January 23, 2002. The results of Purple Ray’s operations have been included in the consolidated financial statements since that date.

Pro forma Financial Information

     The pro forma financial information presented below is presented as if the acquisition of Purple Ray had occurred at the beginning of fiscal 2001. The pro forma statements of operations for the three months ended December 31, 2002 and December 31, 2001, include the historical results of the Company and Purple Ray plus the effect of recurring amortization of the related intangibles and unearned compensation. Such pro forma results do not purport to be indicative of what would have occurred had the acquisition been made as of those dates or the results which may occur in the future. The pro forma financial results are as follows:

	Three Months Ended
	December 31,
	2002			2001
	(In thousands, except per share data)
Net sales	$	21,038		$	15,091
Net loss	$	(12,689	)	$	(10,519	)
Basic and diluted net loss per share	$	(0.46	)	$	(0.39	)
Shares used in basic and diluted per share calculation		27,565			27,036

12

Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations

     We have made forward-looking statements in this report on Form 10-Q that are subject to risks and uncertainties. Forward-looking statements include information concerning possible or assumed future results of our operations. Also, when we use such words as “believe,” “expect,” “anticipate,” or similar expressions, we are making forward-looking statements. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including those set forth below and elsewhere in this report on Form 10-Q.

Background

     Integrated Silicon Solution, Inc. was founded in October 1988. We design, develop and market memory products used in networking, Internet infrastructure, telecommunications, wireless products, handheld devices, computer peripherals, and automotive electronics. Our high speed and low power SRAMs, our low to medium density DRAMs, and our family of EEPROMs enable customers to design products that meet the demanding connectivity, portability and bandwidth requirements of today’s electronic products. Our objective is to capitalize on major trends in electronic products and position ISSI as a key supplier to leading companies in such markets. Our goal is to be a focused supplier of high performance memories targeting the mobile communications, networking/broadband, digital consumer, and automotive electronics markets.

     We believe our close relationship with leading silicon wafer foundries gives us access to the advanced wafer process technology required to design and manufacture high performance memories. We entered into our first development program with Taiwan Semiconductor Manufacturing Corporation (“TSMC”) in 1990 and with Chartered Semiconductor in 1994 and have also worked closely with United Microelectronics Corporation (“UMC”) since 1995. We are also an equity investor and have a seat on the board of directors of Semiconductor Manufacturing International Corporation (“SMIC”), the first eight-inch wafer foundry in China. Through this collaborative strategy, we have been at the forefront in utilizing the most advanced process technology for memories and in securing access to wafer capacity. We believe that ISSI is a technology leader and that our ability to design and develop high performance, cost-effective products, and our collaborative development with our manufacturing partners utilizing state-of-the-art process technology, gives us a competitive advantage.

Results of Operations

     Our financial results for fiscal 2003 and fiscal 2002 reflect accounting for ICSI on the equity basis and include our percentage share of the results of ICSI’s operations. Our financial results for fiscal 2003 and fiscal 2002 reflect accounting for E-CMOS on the equity basis and include our share of E-CMOS’s results of operations on a one quarter lag. Our financial results for fiscal 2003 and fiscal 2002 reflect accounting for GetSilicon, NexFlash and SMIC on the cost basis. At December 31, 2002, we owned approximately 29% of ICSI, approximately 14% of NexFlash, approximately 26% of E-CMOS, approximately 17% of GetSilicon and less than 4% of SMIC.

Critical Accounting Policies

     The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make difficult and subjective estimates, judgments and assumptions. These estimates, judgments and assumptions affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenue and expenses during the reporting period. The estimates and judgments that we use in applying our accounting policies have a significant impact on the results we report in our financial statements. We base our estimates and judgments on our historical experience combined with knowledge of current conditions and our beliefs of what could occur in the future considering the information available at the time. Actual results could differ from those estimates and such differences may be material to our financial statements. We reevaluate our estimates and judgments on an ongoing basis.

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     Our critical accounting policies which are impacted by estimates are: (i) the valuation of our inventory, which impacts cost of goods sold and gross profit; (ii) the valuation of our allowance for sales returns and allowances (iii) the valuation of our allowance for doubtful accounts, which impacts general and administrative expense; and (iv) the valuation of our non-marketable equity securities, which impacts gains and losses on equity securities when we record impairments. Each of these policies is described in more detail below. We also have other key accounting policies that may not require us to make estimates and judgments that are as subjective or difficult, for instance, our policies with regard to revenue recognition, including the deferral of revenues on sales to distributors. These policies are described in the notes to our financial statements contained in this Annual Report on Form 10-K for the year ended September 30, 2002.

Valuation of inventory

     Our inventories are stated at the lower of cost or market value. Determining market value requires us to project unit prices and volumes for future periods in which we expect to sell inventory on hand as of the balance sheet date. As a result of these estimates, we may record a charge to cost of goods sold, which decreases our gross profit, in advance of when the inventory is actually sold to reflect market values that are below our manufacturing and sales commission costs. Conversely, if we sell inventory that has previously been written down to the lower of cost or market at more favorable prices than we had forecasted at the time of the write-down, our gross profit may be higher. In addition to lower of cost or market write-downs, we also analyze inventory to determine whether any of it is excess or obsolete. We write down to zero dollars (which is a charge to cost of goods sold) the carrying value of inventory on hand in excess of six months’ estimated sales volumes to cover estimated excess and obsolete exposures, unless adjustments are made to the forecast based on our judgments for newer products, end of life products or planned inventory increases. In making such judgments to write down inventory, we take into account the product life cycles which can range from 6 to 30 months, the stage in the life cycle of the product, the impact of competitors’ announcements and product introductions on our products.

Valuation of allowance for sales returns and allowances

     Net sales consist principally of total product sales less estimated sales returns. To estimate sales returns and allowances, we analyze potential customer specific product application issues, potential quality and reliability issues and historical returns. We evaluate quarterly the adequacy of the reserve for sales returns and allowances. This reserve is reflected as a reduction to accounts receivable in our consolidated balance sheets. Increases to the reserve are recorded as a reduction to net sales. Because the reserve for sales returns and allowances is based on our judgments and estimates, particularly as to product application, quality and reliability issues, our reserves may not be adequate to cover actual sales returns and other allowances. If our reserves are not adequate, our net sales could be adversely affected.

Valuation of allowance for doubtful accounts

     We maintain an allowance for doubtful accounts for losses that we estimate will arise from our customers’ inability to make required payments for goods and services purchased from us. We make our estimates of the uncollectibility of our accounts receivable by analyzing historical bad debts, specific customer creditworthiness and current economic trends. Once an account is deemed unlikely to be fully collected, we write down the carrying value of the receivable to the estimated recoverable value, which results in a charge to general and administrative expense, which decreases our profitability.

Valuation of non-marketable securities

     Our ability to recover our investments in equity securities that are non-marketable and to earn a return on these investments is largely dependent on financial market conditions and the occurrence of liquidity events, such as initial public offerings, mergers or acquisitions and private party transactions. All of these events are difficult to predict, particularly in the current economic environment. In addition, under our accounting policy, we are required to periodically review all of our investments for impairment. In the case of non-marketable

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equity securities, this requires significant judgment on our part, including an assessment of the investees’ financial condition, the existence of subsequent rounds of financing and the impact of any relevant contractual equity preferences, as well as the investees’ historical results of operations, and projected results and cash flows. If the actual outcomes for the investees’ are significantly different from their forecasts, the carrying value of our non-marketable equity securities may be overstated, and we may incur additional charges in future periods, which will decrease our profitability. At December 31, 2002, our strategic investments in non-marketable securities totaled $46.7 million of which $40.0 million was invested in SMIC.

Three Months Ended December 31, 2002 Compared to Three Months Ended December 31, 2001

     Net Sales. Net sales consist principally of total product sales less estimated sales returns. Net sales increased by 39% to $21.0 million in the three months ended December 31, 2002 from $15.1 million in the three months ended December 31, 2001. The increase in sales was principally due to an increase in unit shipments of our DRAM products partially offset by declines in the average selling prices in the three months ended December 31, 2002 compared to the three months ended December 31, 2001. While SRAM units shipped increased in the three months ended December 31, 2002 compared to the three months ended December 31, 2001, the impact of the reduction in average selling prices resulted in an overall reduction in SRAM revenue. We anticipate that the average selling prices of our existing products will generally decline over time, although the rate of decline may fluctuate for certain products. In this regard, we experienced a decline in the average selling prices for certain of our SRAM and DRAM products in the three months ended December 31, 2002 as compared to the three months ended September 30, 2002. We anticipate further price declines for certain of our SRAM and DRAM products in the March 2003 quarter. There can be no assurance that such declines will be offset by higher volumes or by higher prices on newer products.

     In the three months ended December 31, 2002 and December 31, 2001, no single customer accounted for over 10% of net sales. However, in the three months ended December 31, 2001, shipments for Cisco directly, or indirectly through subcontractors, accounted for approximately 14% of net revenue. As sales to our customers are executed pursuant to purchase orders and no purchasing contract exists, our customers can cease doing business with us at any time.

     Gross Profit (loss). Cost of sales includes die cost from the wafers acquired from foundries, subcontracted package costs, assembly costs and test costs, costs associated with in-house product testing, quality assurance and import duties. Gross profit decreased 145% to $(1.2) million in the three months ended December 31, 2002 from $2.7 million in the three months ended December 31, 2001. As a percentage of net sales, gross profit decreased to (5.8)% in the three months ended December 31, 2002 from 17.8% in the three months ended December 31, 2001. In the three months ended December 31, 2002, we recorded inventory write-downs of $4.1 million predominately for lower of cost or market accounting. Excluding the inventory write-downs in the three months ended December 31, 2002, the decrease in gross profit was principally due to a significant decline in the average selling prices of our products in the three months ended December 31, 2002 compared to the three months ended December 31, 2001. Further, as we sell products that had previously been written-down to lower of cost or market, we recognize minimal gross profit. Our margin for the three months ended December 31, 2002 benefited from the sale of $0.6 million of parts previously written down to zero carrying value. The decline in our gross margin in fiscal 2002 was more significant for our SRAM products than for our DRAM products. In addition, we were able to offset some of the decline in average selling prices of our DRAM products with an increase in DRAM units shipped. We believe that the average selling price of our products will generally decline over time and, unless we are able to reduce our cost per unit to the extent necessary to offset such declines, the decline in average selling prices will result in a material decline in our gross margin. In this regard, we experienced a decline in the average selling prices for certain of our SRAM and DRAM products in the three months ended December 31, 2002 compared to the three months ended September 30, 2002. We anticipate a further decline in the average selling prices for certain of our SRAM and DRAM products in the three months ending March 31, 2003. In addition, product unit costs could increase if our suppliers raise prices, which could result in a material decline in our gross margin. Although we have product cost reduction programs in place for certain products that involve efforts to reduce internal costs and supplier costs, there can be no assurance that product costs will be reduced or that such reductions will be sufficient to

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offset the expected declines in average selling prices. We do not believe that such cost reduction efforts are likely to have a material adverse impact on the quality of our products or the level of service provided by us.

     Research and Development. Research and development expenses remained relatively flat at $6.8 million in the three months ended December 31, 2002 compared to $6.6 million in the three months ended December 31, 2001. As a percentage of net sales, research and development expenses decreased to 32.3% in the three months ended December 31, 2002 from 44.0% in the three months ended December 31, 2001. The increase in absolute dollars was the result our acquisition of Purple Ray and the expansion of our research and development activities in Asia, partially offset by a decline in contracted development charges. While we have made efforts to reduce research and development expenses through salary reductions, lay-offs and the transfer of some design and engineering efforts to Asia, these reductions may be offset by increased costs for the development of new products, which could result in our research and development expenses increasing in absolute dollars in future periods.

     Selling, General and Administrative. Selling, general and administrative expenses were $3.7 million in both the three months ended December 31, 2002 and December 31, 2001. As a percentage of net sales, selling, general and administrative expenses decreased to 17.4% in the three months ended December 31, 2002 from 24.3% in the three months ended December 31, 2001. We have controlled expenses through salary reductions, lay-offs and limiting discretionary spending. We expect our selling, general and administrative expenses may increase in future quarters although such expenses may fluctuate as a percentage of net sales.

     Gain on sale of investments. The gain on the sale of investments decreased to $0 in the three months ended December 31, 2002 from $35,000 in the three months ended December 31, 2001. In the three months ended December 31, 2001, we sold shares of ICSI for approximately $64,000 resulting in a pre-tax gain of $35,000.

     Other income (expense), net. Other income (expense), net decreased by $0.5 million to approximately $18,000 in the three months ended December 31, 2002 from $0.5 million in the three months ended December 31, 2001. The decrease was primarily the result of decreased interest income as the result of lower cash balances. In addition, in the three months ended December 31, 2002, we recorded a charge of approximately $277,000 related to the decline in the fair value of an embedded derivative associated with the ICSI convertible debenture. We recorded a charge of $150,000 for the impairment of an investment during the three months ended December 31, 2001.

     Minority interest in net loss of consolidated subsidiary. In October 2001, we invested $3.0 million for a 95% interest in D2Code Co. Inc. (“D2Code”), a subsidiary that we established in Korea to focus on semiconductor design activities. The results of their operations are included in our consolidated financial statements. The minority interest in net loss of consolidated subsidiary, represents the minority shareholders’ proportionate share of the net loss of D2Code. The minority interest in net loss of consolidated subsidiary increased to $17,000 in the three months ended December 31, 2002 from $9,000 in the three months ended December 31, 2001.

     Equity in net loss of affiliated companies. Equity in net loss of affiliated companies decreased by $1.9 million to $1.0 million in the three months ended December 31, 2002 from $2.9 million in the three months ended December 31, 2001. This primarily reflects a decrease in the loss from our percentage share of ICSI’s financial results in the three months ended December 31, 2002 compared to the three months ended December 31, 2001.

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Liquidity and Capital Resources

     As of December 31, 2002, our principal sources of liquidity included cash, cash equivalents and short-term investments of approximately $75.0 million. During the three months ended December 31, 2002, operating activities used cash of approximately $3.4 million compared to $1.0 million in the three months ended December 31, 2001. Cash used by operations was primarily due to net loss of $12.7 million adjusted for depreciation of $1.2 million, equity in net loss of affiliated companies of $1.0 million, other non-cash items of $0.3 million and increases in accounts receivables of $0.9 million. This was partially offset by decreases in inventories of $5.2 million primarily driven by inventory write-downs, increases in accounts payable of $1.4 million, increases in accrued expenses of $0.6 million and decreases in other assets of $0.4 million.

     In the three months ended December 31, 2002, we generated $9.1 million from investing activities compared to $7.4 million in the three months ended December 31, 2001. The cash generated by investing activities in the three months ended December 31, 2002 primarily resulted from net sales of available-for-sale securities of $9.7 million. The cash generated from investing activities in the three months ended December 31, 2001 was primarily the result of net sales of available-for-sale securities of $11.8 million. In addition, we invested $3.8 million in Semiconductor Manufacturing International Corp (“SMIC”).

     In the three months ended December 31, 2002, we made capital expenditures of approximately $0.6 million for engineering tools and computer software. We expect to spend approximately $2.0 million to $3.0 million to purchase capital equipment during the next twelve months, principally for the purchase of design and engineering tools, additional test equipment and computer software and hardware.

     We generated $0.1 million from financing activities during the three months ended December 31, 2002 compared to $0.4 million in the three months ended December 31, 2001. The source of financing for the current quarter was proceeds from the issuance of common stock of $0.1 million from stock option exercises.

     In August 2000, we made a commitment for an equity investment in SMIC. In fiscal 2002, we made investments totaling $21.2 million in SMIC, bringing our total investment in this foundry as of December 31, 2002, to $40.0 million. We have no further commitments to SMIC for additional equity investments at this time. We have received certain capacity commitments from SMIC. In addition, we have remaining non-cancelable purchase commitments to another wafer foundry for approximately $0.6 million over the next 6 months.

     In July 2002, we made a commitment for an equity investment in Signia Technologies, Inc. (“Signia”), a development stage company focusing on BlueTooth™ design. At December 31, 2002, our investment in Signia was $1.5 million. We were committed to invest an additional $1.5 million in Signia, if Signia achieved certain milestones with respect to its BlueTooth™ product by January 19, 2003. As Signia did not achieve the milestones by January 19, 2003, we are no longer obligated to this commitment.

     We lease our facilities including our headquarters in Santa Clara, California, our field sales offices in the U.S. and Europe and sales and engineering offices in Asia. Our leases expire at various dates through 2007. Our outstanding commitments under these leases are approximately $6.5 million.

     Our contractual cash obligations at December 31, 2002 are outlined in the table below:

	Payments Due by Period (in thousands)
	Total		Fiscal 2003			Fiscal 2004 - 2005		Fiscal 2006 - 2007
Contractual Obligations
Equipment lease debt	$	116	$	116	$	—	$	—
Operating leases		6,485		1,056		3,216		2,213
Unconditional purchase obligations with wafer foundries		609		609		—		—
Total contractual cash obligations	$	7,210	$	2,083	$	3,216	$	2,213

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     We believe our existing funds and available financing will satisfy our anticipated working capital and other cash requirements through at least the next 12 months. We may from time to time take actions to further increase our cash position through bank borrowings, sales of additional shares of ICSI, the disposition of certain assets, equity financing or debt financing. From time to time, we also evaluate potential acquisitions and equity investments complementary to our memory expertise and market strategy, including investments in wafer fabrication foundries. To the extent we pursue such transactions, any such transaction could require us to seek additional equity or debt financing to fund such activities. There can be no assurance that any such additional financing could be obtained on terms acceptable to us, if at all.

Certain Factors Which May Affect Our Business or Future Operating Results

Our operating results are expected to continue to fluctuate and may not meet published analyst forecasts. This may cause the price of our common stock to decline.

     Our future quarterly and annual operating results are subject to fluctuations due to a wide variety of factors, including:

• the cyclicality of the semiconductor industry;

• decreases in the demand for our products;

• excess inventory levels at our customers;

• declines in average selling prices of our products;

• cancellation of existing orders or the failure to secure new orders;

• oversupply of memory products in the market;

• our failure to introduce new products and to implement technologies on a timely basis;

• market acceptance of ours and our customers’ products;

• economic slowness and low end-user demand;

• our failure to anticipate changing customer product requirements;

• fluctuations in manufacturing yields;

• our failure to deliver products to customers on a timely basis;

• disruption in the supply of wafers or assembly services;

• changes in product mix;

• the timing of significant orders;

• increased expenses associated with new product introductions, masks, or process changes;

• the ability of customers to make payments to us; and

• the commencement of, or developments with respect to, any future antidumping proceedings.

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We have incurred significant losses in certain recent periods, and there can be no assurance that we will be able to achieve or sustain profitability in the future.

     We have incurred losses in the seven consecutive quarters ended December 31, 2002 totaling $109.7 million. We expect to incur a loss in the March 2003 quarter and may incur losses in subsequent quarters. We were profitable for fiscal 2001 and fiscal 2000. Our ability to achieve or maintain profitability on a quarterly basis in the future will depend on a variety of factors, including our ability to increase our net sales, introduce new products on a timely basis, secure sufficient wafer fabrication capacity and control our operating expenses. Adverse developments with respect to these or other factors could result in quarterly or annual operating losses in the future.

Any continued downturn in the markets we serve would harm our business.

     Substantially all of our products are incorporated into products such as internet access devices, networking equipment, digital consumer products, telecom/mobile communications devices, and automotive electronics. Historically, these markets have from time to time experienced cyclical, depressed business conditions, often in connection with, or in anticipation of, a decline in general economic conditions. Such industry downturns have resulted in reduced product demand and declining average selling prices. These markets are currently experiencing severely depressed business conditions which are adversely affecting our business. We are unable to predict how long this current downturn will continue or whether current conditions will worsen.

Our sales depend on SRAM and DRAM products, and a decline in average selling prices or reduced demand for these products could harm our business.

     A substantial majority of our net sales are derived from the sale of DRAM and SRAM products, which are subject to unit volume fluctuations and declines in average selling prices which could harm our business. For example, in the three months ended September 30, 2001, our net sales decreased by 26% to $14.8 million from $20.0 million in the three months ended June 30, 2001, principally due to a decline in average selling prices for our products including our SRAM products. In addition, in the three months ended June 30, 2001, our net sales decreased by 62% to $20.0 million from $52.0 million in the three months ended March 31, 2001, and decreased 20% in the three months ended March 31, 2001 from $65.2 million in the three months ended December 31, 2000, principally due to a decrease in unit shipments of our SRAM products as a result of lower demand for electronic products. While unit shipments of certain SRAM products increased in the three months ended December 31, 2002 compared to the three months ended September 30, 2002, declines in the average selling prices for our SRAM products resulted in an overall decline in our SRAM revenue. We anticipate further price declines for certain of our SRAM and DRAM products in the March 2003 quarter. There can be no assurance that such declines will be offset by higher volumes or by higher prices on newer products.

We may not be able to compensate for price decreases in our products.

     Competitive pricing pressures due to an industry-wide oversupply of wafer capacity as well as product inventory resulted in significant price decreases for our products during fiscal 1996 through fiscal 1999. While we experienced increases in average selling prices in fiscal 2000, historically, average selling prices for semiconductor memory products have declined, and we expect that average selling prices will decline in the future. In this regard, we experienced a decline in the average selling prices for most of our products during fiscal 2002, and in the most recent quarter ended December 31, 2002. We anticipate a further decline in the average selling prices for certain of our SRAM and DRAM products in the March 2003 quarter. Our ability to maintain or increase revenues will depend upon our ability to increase unit sales volume of existing products and introduce and sell new products which compensate for the anticipated declines in the average selling prices of our existing products.

     Declining average selling prices will also adversely affect our gross margins and profits unless we are able to introduce new products with higher margins or reduce our cost per unit. We may not be able to increase unit sales volumes, introduce and sell new products or reduce our cost per unit.

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Shifts in industry-wide capacity may cause our results to fluctuate. In the past, such shifts have resulted in significant inventory write-downs.

     Shifts in industry-wide capacity from shortages to oversupply or from oversupply to shortages may result in significant fluctuations in our quarterly or annual operating results. The semiconductor industry is highly cyclical and is subject to significant downturns resulting from excess capacity, overproduction, reduced demand or technological obsolescence. These factors can result in a decline in average selling prices and the stated value of inventory. In the three months ended December 31, 2002, in fiscal 2002 and in fiscal 2001, we recorded inventory write-downs of $4.1 million, $28.6 million and $38.3 million, respectively. The inventory write-downs were predominately for lower of cost or market accounting on our products, and to a lesser extent, excess inventory.

     We write down to zero carrying value inventory on hand in excess of six months’ estimated sales volumes to cover estimated excess and obsolete exposures, unless adjustments are made to the forecast based on management’s judgments for newer products, end of life products or planned inventory increases. In making such judgments to write down inventory, management takes into account the product life cycles which can range from 6 to 30 months, the stage in the life cycle of the product, the impact of competitors’ announcements and product introductions on our products.

     We believe that six months is an appropriate period because it is difficult to accurately forecast for a specific product beyond this time frame due to the potential introduction of products by competitors, technology obsolescence or fluctuations in demand. Our policy regarding excess inventory resulted in inventory write-downs for excess inventory of approximately $10.4 million for fiscal 2002 and $5.7 million for fiscal year 2001. Future additional inventory write-downs may occur due to lower of cost or market accounting, excess inventory or inventory obsolescence.

If we are unable to obtain an adequate supply of wafers, our business will be harmed.

     If we are unable to obtain an adequate supply of wafers from our current or any alternative sources in a timely manner, our business will be harmed. To date, our principal manufacturing relationship has been with TSMC, from which we have obtained a majority of our wafers. We also receive wafers from Chartered Semiconductor, SMIC, and UMC. Each of our wafer foundries also supplies wafers to other integrated circuit companies, including certain of our competitors. Although we have written commitments specifying wafer capacities from some suppliers, if any suppliers experience manufacturing failures or yield shortfalls, choose to prioritize capacity for other uses, or reduce or eliminate deliveries to us, we may not be able to enforce fulfillment of any delivery commitments. Additionally, we may not be able to qualify additional manufacturing sources for existing or new products in a timely manner and we cannot be certain that other manufacturing sources would agree to deliver an adequate supply of wafers to us.

Foundry capacity can be limited and we may be required to enter into costly long-term supply arrangements to secure foundry capacity.

     If we are not able to obtain additional foundry capacity as required, our relationships with our customers would be harmed and our future sales would be adversely impacted. In order to secure additional foundry capacity, we have entered into and may enter into various arrangements with suppliers, which could include:

• contracts that commit us to purchase specified quantities of silicon wafers over extended periods;

• investments in foundries;

• joint ventures;

• other partnership relationships with foundries;

• option payments or other prepayments to foundries; or

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• nonrefundable deposits with or loans to foundries in exchange for capacity commitments.

     We may not be able to make any such arrangements in a timely fashion or at all, and such arrangements, if any, may not be on terms favorable to us. Moreover, if we are able to secure foundry capacity, we may be obligated to utilize all of that capacity or incur penalties. Such penalties may be expensive and could harm our financial results.

We depend on a small number of customers for a high percentage of our sales, and the loss of a significant customer could cause a decline in our profits.

     In the three months ended December 31, 2002, no single customer accounted for over 10% of net sales. In fiscal 2002, no single customer accounted for over 10% of net sales. However, in fiscal 2001, sales to Flextronics International accounted for approximately 15% of net sales. Substantially all of our sales to Flextronics were for products to be delivered to Cisco. Shipments for Cisco directly, or indirectly through subcontractors, accounted for approximately 18% of our net sales for fiscal 2001. Shipments for 3Com directly, or indirectly through subcontractors, accounted for approximately 11% of net sales for fiscal 2001. As sales to our customers are executed pursuant to purchase orders and no purchasing contract exists, our customers can cease doing business with us at any time. In this regard, we experienced order cancellations from these customers in the March 2001 quarter which adversely impacted our operating results in subsequent quarters. We expect a significant portion of our future sales to remain concentrated within a limited number of strategic customers. We may not be able to retain our strategic customers, such customers may cancel or reschedule orders, or in the event of canceled orders, such orders may not be replaced by other sales. In addition, sales to any particular customer may fluctuate significantly from quarter to quarter, and such fluctuating sales could harm our business.

Our products are complex and could contain defects, which could reduce sales of those products or result in claims against us.

     We develop complex and evolving products. Despite testing by us and our customers, errors may be found in existing or new products. This could result in a delay in recognition or loss of revenues, loss of market share or failure to achieve market acceptance. These defects also may cause us to incur significant warranty, support and repair costs, may divert the attention of our engineering personnel from our product development efforts and could harm our relationships with our customers. The occurrence of these problems could result in the delay or loss of market acceptance of our products and would likely harm our business. Defects, integration issues or other performance problems in our products could result in financial or other damages to our customers or could lessen market acceptance of our products. Our customers could also seek and obtain damages from us for their losses. Although we specifically limit our liability to replacement of defective items or return of amounts paid, a product liability claim brought against us, even if unsuccessful, would likely be time consuming and costly to defend.

Strong competition in the semiconductor memory market may harm our business.

     The semiconductor memory market is intensely competitive and has been characterized by an oversupply of product, price erosion, rapid technological change, short product life cycles, cyclical market patterns and heightened foreign and domestic competition. Certain of our competitors offer broader product lines and have greater financial, technical, marketing, distribution and other resources than us. We may not be able to compete successfully against any of these competitors. Our ability to compete successfully in the high performance memory market depends on factors both within and outside of our control, including:

• real or perceived imbalances in supply and demand;

• product pricing;

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• the rate at which OEM customers incorporate our products into their systems;

• the success of our customers’ products and end-user demand;

• access to advanced process technologies at competitive prices;

• product functionality, performance and reliability;

• successful and timely product development;

• the supply and cost of wafers;

• achievement of acceptable yields of functional die;

• the gain or loss of significant customers; and

• the nature of our competitors and general economic conditions.

     In addition, we are vulnerable to technology advances utilized by competitors to manufacture higher performance or lower cost products. We may not be able to compete successfully in the future as to any of these factors. Our failure to compete successfully in these or other areas could harm our business.

Potential intellectual property claims and litigation could subject us to significant liability for damages and could invalidate our proprietary rights.

     In the semiconductor industry, it is not unusual for companies to receive notices alleging infringement of patents or other intellectual property rights of others. We have been, and from time-to-time expect to be, notified of claims that we may be infringing patents, maskwork rights or copyrights owned by third parties. If it appears necessary or desirable, we may seek licenses under patents that we are alleged to be infringing. Although patent holders commonly offer such licenses, licenses may not be offered and the terms of any offered licenses may not be acceptable to us.

     The failure to obtain a license under a key patent or intellectual property right from a third party for technology used by us could cause us to incur substantial liabilities and to suspend the manufacture of the products utilizing the invention or to attempt to develop non-infringing products, any of which could materially and adversely affect our business and operating results. Furthermore, we may become involved in protracted litigation regarding the alleged infringement by us of third party intellectual property rights or litigation to assert and protect our patents or other intellectual property rights. Any litigation relating to patent infringement or other intellectual property matters could result in substantial cost and diversion of our resources which could harm our business.

We have significant international sales and risks related to our international operations could harm our operating results.

     In the three months ended December 31, 2002, approximately 19% of our net sales was attributable to customers located in the United States, 13% was attributable to customers located in Europe and 68% was attributable to customers located in Asia. In fiscal 2002, approximately 30% of our net sales was attributable to customers located in the United States, 15% was attributable to customers located in Europe and 55% was attributable to customers located in Asia. In fiscal 2001, approximately 52% of our net sales was attributable to customers located in the United States, 25% was attributable to customers located in Europe and 23% was attributable to customers located in Asia. Accordingly, our future operating results will depend on general economic conditions in Asia, Europe, and the United States. In addition, the markets for our products, which are highly cyclical, may not continue to grow. We anticipate that sales to international customers will continue to represent a significant percentage of net sales.

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     We are subject to the risks of conducting business internationally, including:

• economic conditions in Europe and Asia, particularly in Taiwan and the People’s Republic of China;

• changes in trade policy and regulatory requirements;

• duties, tariffs and other trade barriers and restrictions;

• the burdens of complying with foreign laws;

• foreign currency fluctuations;

• difficulties in collecting foreign accounts receivable; and

• political instability.

We have made strategic equity investments in other companies with no assurance that they will increase in value.

     Over the last few years, we have made several strategic equity investments in other technology companies. At December 31, 2002, we had investments in equity securities of privately held companies of approximately $46.7 million, $40 million of which is in SMIC. There can be no assurance that these investments will increase in value and there is the possibility that they could decrease in value over time, even to the point of becoming completely worthless. These investments are tested for impairment on a recurring basis and any reductions in the carrying value would lower our profitability. In this regard, we recorded approximately $397,000 in impairment losses during fiscal 2002.

We may encounter difficulties in effectively integrating acquired businesses.

     From time to time, we may acquire other companies that would be complementary to our business. Acquisitions may result in potentially dilutive issuances of equity securities, incurrence of debt and contingent liabilities, amortization expenses related to intangible assets and the possible impairment of goodwill, which could harm our profitability. In addition, acquisitions involve numerous risks, including, among other things: higher than estimated acquisition expenses; difficulties in successfully assimilating the operations, technologies and personnel of the acquired company; diversion of management’s attention from other business concerns; risks of entering markets in which we have no or limited direct prior experience; and the potential loss of key employees and customers as a result of the acquisition. In this regard, in February 2002, we acquired Purple Ray, Inc., a privately held research and development stage company developing network search engine and content addressable memory integrated circuits. Pursuant to this transaction, we issued 438,000 shares of our common stock in exchange for all outstanding shares of Purple Ray and may issue up to an additional 163,000 shares upon exercise of warrants and options of Purple Ray. Approximately 50,000 additional shares of our common stock may be issued contingent upon meeting certain milestones. There can be no assurance as to the effect of the Purple Ray acquisition or future acquisitions on our business or operating results.

We depend on our ability to attract and retain our key technical and management personnel.

     Our success depends upon the continued service of our key technical and management personnel, including Jimmy S.M. Lee, our Chairman and Chief Executive Officer, and Gary L. Fischer, our President, Chief Operating Officer, and Chief Financial Officer, as well as on our ability to continue to attract, retain and motivate qualified personnel, particularly experienced circuit designers and process engineers. The competition for such employees is intense. We have no employment contracts or key person life insurance policies with or for any of our executive officers. The loss of the service of one or more of our key personnel could materially and adversely affect our business and operating results.

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Terrorist attacks, threats of further attacks, threats of war, and acts of war may negatively impact all aspects of our operations, revenues, costs and stock price.

     The September 2001 terrorist attacks in the United States, as well as future events occurring in response or connection to them, including, future terrorist attacks against United States targets, rumors or threats of war, actual conflicts involving the United States or its allies, or trade disruptions impacting our domestic or foreign suppliers or our customers, may impact our operations and may, among other things, cause delays or losses in the delivery of wafers or other products to us and decreased sales of our products. More generally, these events have affected, and are expected to continue to affect, the general economy and customer demand for products sold by our customers. Any of these occurrences could have a significant impact on our operating results, revenues, and costs, which in turn may result in increased volatility in our common stock price and a decline in the price of our common stock.

Our stock price is expected to be volatile.

     The trading price of our common stock has been and is expected to be subject to wide fluctuations in response to:

• quarter-to-quarter variations in our operating results;

• new or revised earnings estimates;

• comments or recommendations issued by analysts who follow us, our competitors or the semiconductor industry and other events or factors;

• aggregate valuations and movement of stocks in the broader semiconductor industry;

• announcements of new products, strategic relationships or acquisitions by us or our competitors;

• increases or decreases in wafer capacity;

• general conditions or cyclicality in the semiconductor industry or the end markets that we serve;

• governmental regulations, trade laws and import duties;

• announcements related to future or existing litigation involving us or any of our competitors;

• announcements of technological innovations by us or our competitors;

• additions or departures of senior management; and

• other events or factors many of which are beyond our control.

     In addition, stock markets have experienced extreme price and trading volume volatility in recent years. This volatility has had a substantial effect on the market prices of securities of many high technology companies for reasons frequently unrelated to the operating performance of the specific companies. These broad market fluctuations may adversely affect the market price of our common stock.

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Item 3.   Financial Market Risk

     Our financial market risk includes risks associated with international operations and related foreign currencies. We anticipate that international sales will continue to account for a significant portion of our consolidated revenue. Our international sales are largely denominated in U.S. dollars and therefore are not subject to material foreign currency exchange risk. We have operations in China, Europe, Taiwan, Hong Kong, and Korea. Expenses of our international operations are denominated in each country’s local currency and therefore are subject to foreign currency exchange risk; however, through December 31, 2002 we have not experienced any significant negative impact on our operations as a result of fluctuations in foreign currency exchange rates. We do not currently engage in any hedging activities, and our derivative financial instruments were immaterial at December 31, 2002.

     We had short-term investments of $57.5 million at December 31, 2002. The primary objective of our investment activities is to preserve principal while at the same time maximizing yields without increasing risk. We invest primarily in high-quality, short-term debt instruments such as municipal auction rate certificates and instruments issued by high quality financial institutions and companies, including money market instruments. A hypothetical one percentage point decrease in interest rates would result in approximately a $0.7 million decrease in interest income.

     We own approximately 29% of ICSI, a public company listed on the Taiwan Stock Exchange. We account for this investment on the equity basis and our investment balance as of December 31, 2002 was approximately $14.7 million. The market value of our investment in the common stock of ICSI at December 31, 2002 was approximately $27.0 million, based on quoted market prices. The share price of ICSI is subject to fluctuations. A significant decline in the stock price of ICSI may require us to record a loss related to this investment. In addition, we own approximately $2.5 million of ICSI convertible debentures. As a result of a decline in ICSI’s convertible bond price, the we recorded an unrealized loss of approximately $248,000 related to the ICSI convertible debentures in the December 2002 quarter. This loss was included in other comprehensive loss in the equity portion of our balance sheet. In addition, in the December 2002 quarter, the we recorded a charge of approximately $277,000 related to the decline in the fair value of an embedded derivative associated with the ICSI convertible debenture. The charge associated with the embedded derivative is included in other income (expense). Further deterioration in ICSI’s bond price would result in additional losses.

     We have investments in equity securities of privately held companies for the promotion of business and strategic objectives of approximately $42.9 million at December 31, 2002, of which $40.0 million is invested in SMIC. These investments are generally in companies in the semiconductor industry. These investments are included in other assets and are accounted for using the cost method. In addition, we have an investment of $3.8 million that is accounted for on the equity method. For investments in which no public market exists, our policy is to review the operating performance, recent financing transactions and cash flow forecasts for such companies in assessing the net realizable values of the securities of these companies. Impairment losses on equity investments are recorded when events and circumstances indicate that such assets are impaired and the decline in value is other than temporary. We recorded $397,000 in impairment losses during fiscal 2002.

Item 4.   Controls and Procedures

Evaluation of Disclosure Controls and Procedures

     Our chief executive officer and our chief financial officer, after evaluating the effectiveness of our “disclosure controls and procedures” (as defined in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934) as of a date within 90 days of our filing of this quarterly report on Form 10-Q (referred to as the “Evaluation Date”), have concluded that, as of the Evaluation Date, our disclosure controls and procedures were adequate and effective to ensure the timely collection, evaluation and disclosure of information relating to us and our consolidated subsidiaries, if any, that would potentially be subject to disclosure under the Securities Exchange Act of 1934, as amended, and the rules and regulations promulgated thereunder.

25

Changes in Internal Controls

     There were no significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the Evaluation Date. No significant deficiencies or material weaknesses were identified in the evaluation of our internal controls and therefore no corrective actions have been taken.

Part II. OTHER INFORMATION

Item 6.   Exhibits and Reports on Form 8-K

     (a)  The following exhibits are filed as a part of this report.

Exhibit 99.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

     (b)  Reports on Form 8-K.

     The registrant did not file any reports on Form 8-K during the quarter ended December 31, 2002.

26

SIGNATURES

     Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	Integrated Silicon Solution, Inc.
	(Registrant)
Dated: February 14, 2003	/s/ Gary L. Fischer
	Gary L. Fischer President, Chief Operating Officer, and Chief Financial Officer (Principal Financial and Accounting Officer)

27

CERTIFICATION

     I, Jimmy S.M. Lee, certify that:

1.	I have reviewed this quarterly report on Form 10-Q of Integrated Silicon Solution, Inc.;
2.	Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
3.	Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;
4.	The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

(a)	Designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
(b)	Evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and
(c)	Presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5. The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):

(a)	All significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and
(b)	Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

6 The registrant’s other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Date: February 14, 2003

/s/ Jimmy S.M. Lee
Jimmy S.M. Lee
Chief Executive Officer

28

CERTIFICATION

     I, Gary L. Fischer, certify that:

1.	I have reviewed this quarterly report on Form 10-Q of Integrated Silicon Solution, Inc.;
2.	Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
3.	Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;
4.	The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

(a)	Designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
(b)	Evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and
(c)	Presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5. The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):

(a)	All significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and
(b)	Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

6. The registrant’s other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Date: February 14, 2003

/s/ Gary L. Fischer
Gary L. Fischer
President, Chief Operating Officer, and
Chief Financial Officer

29

Exhibits Index

Exhibit No.	Description
Exhibit 99.1	Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

30 EX-99.1 3 f87680exv99w1.txt EXHIBIT 99.1 Exhibit 99.1 CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 I, Jimmy S.M. Lee, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that the Quarterly Report of Integrated Silicon Solution, Inc. on Form 10-Q for the quarterly period ended December 31, 2002 fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and that information contained in such Report on Form 10Q fairly presents in all material respects the financial condition and results of operations of Integrated Silicon Solution Inc. By: /s/ Jimmy S.M. Lee ------------------------------------------------- Jimmy S.M. Lee Chairman of the Board and Chief Executive Officer February 14, 2003 I, Gary L. Fischer, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that the Quarterly Report of Integrated Silicon Solution, Inc. on Form 10-Q for the quarterly period ended December 31, 2002 fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and that information contained in such Report on Form 10Q fairly presents in all material respects the financial condition and results of operations of Integrated Silicon Solution Inc. By: /s/ Gary L. Fischer ------------------------------------------------- Gary L. Fischer President, Chief Operating Officer and Chief Financial Officer February 14, 2003 -----END PRIVACY-ENHANCED MESSAGE-----

EX-99.1

                                                                    Exhibit 99.1



      CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER
                                  PURSUANT TO
                            18 U.S.C. SECTION 1350,
                             AS ADOPTED PURSUANT TO
                 SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002


I, Jimmy S.M. Lee, certify, pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that the Quarterly
Report of Integrated Silicon Solution, Inc. on Form 10-Q for the quarterly
period ended December 31, 2002 fully complies with the requirements of Section
13(a) or 15(d) of the Securities Exchange Act of 1934 and that information
contained in such Report on Form 10Q fairly presents in all material respects
the financial condition and results of operations of Integrated Silicon Solution
Inc.


                           By: /s/ Jimmy S.M. Lee
                               -------------------------------------------------
                               Jimmy S.M. Lee
                               Chairman of the Board and Chief Executive Officer
                               February 14, 2003




I, Gary L. Fischer, certify, pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that the Quarterly
Report of Integrated Silicon Solution, Inc. on Form 10-Q for the quarterly
period ended December 31, 2002 fully complies with the requirements of Section
13(a) or 15(d) of the Securities Exchange Act of 1934 and that information
contained in such Report on Form 10Q fairly presents in all material respects
the financial condition and results of operations of Integrated Silicon Solution
Inc.


                           By: /s/ Gary L. Fischer
                               -------------------------------------------------
                               Gary L. Fischer
                               President, Chief Operating Officer and
                               Chief Financial Officer
                               February 14, 2003